Who is building the institutions of the Twenty-First Century ?

The pursuit of innovation and value creation through free market competition and entrepreneurial activity has been one of the greatest drivers of human progress to date. It is not without its problems, of course, but so closely does it mirror the process of adaptation and evolution found everywhere in nature that many of these issues, such as inequality of opportunity and the dynamics of scale-free networks, are also facts of life.

But many of the business institutions and practices that we took for granted in the Twentieth Century do not seem to be performing well, and are in some cases no longer fit for purpose. In the world of new technology, in particular, there is a growing belief that today’s startups can disrupt and replace under-performing C20th institutions and corporations, but is that really the case, or are startups more interested to flip, pivot and fold once a pay-off is in sight? I find this question interesting because it goes to the heart of the nature of the firm and the role of institutions in general, so I tried to tackle it in my talk at the wonderful Meaning Conference in the UK last week. Here is the video and below is my summary.

What are the goals of business? We have grown up accepting the C20th corporate answer to this, which is the maximisation of shareholder value and the single-minded pursuit of profit. But even these apparently simple formulae can be unpacked to reveal more complex questions, such as the relationship between business value creation and stock price, and the issue of short-term versus long-term profitability. Leaving aside for a moment moral questions concerning sustainability in the widest sense, this myopic vision of what constitutes a business is no longer even working for shareholders, prompting the Financial Times to write recently that:

Executives should take an enlightened view of their companies. Financial incentives could be improved by forcing directors to keep a large portion of their wealth tied up in company shares for years after they leave the helm. But a perfect alignment of interests is likely to remain elusive … Corporate insiders should therefore be held to a more nuanced principle than unbounded self-interest. Business leaders should be ambitious for their companies, not greedy for themselves.

I am fascinated by the Wikipedia page listing the world’s oldest companies, and a couple of things stand out for me, such as the disproportionate number of German and Japanese companies and also the roots of many of these firms in some kind of mastery or craft, rather than straightforward rent- or profit-seeking. It strikes me that the majority of very old firms had a blend of business goals, and would not have lasted so long if they stuck to the modern-day formula of the short-term maximisation of shareholder value.

The nature of money has also changed a lot over time, and for long periods having only the goal of capital accumulation made little sense as its value went down over time, not up, and so entrepreneurs have pursued a blend of goals covering short-term capital accumulation, longer term power and influence, and in almost all previous eras, a form of social status that the most rapacious capitalists today seem content to forego in favour of higher levels of physical security.

There are, of course, other ways to measure value than cash at bank, and in Germany and Japan in particular, there remains a sense that companies are part of a society that they have some responsibility towards, as it provides employees, customers and suppliers, and is part of the ecosystem within which they operate. Germany’s industrial base is still mostly located in the towns and cities where firms began, but that is not the case in the UK. Creating shared value, or as Mikel Lezamiz from Mondragon put it in his excellent talk at Meaning, “creating wealth for society” is a positive outcome for business, not least because it nurtures a supportive ecosystem that can become an advantage in harder times.

In fact, as Clayton Christensen has argued, the domination of business by finance creates bigger problems for the future. Whereas finance was once a service to business by providing liquidity, it has come to own business to the extent that investing in innovation is just one possible use for capital among other, less risky and less productive options. Instead of re-investing cost savings derived from efficiencies in what Christensen calls empowering innovations, much of that cash is being hoarded or invested in financial instruments, rather than value creation.

How do today’s startups change this picture? At their best, they are magical alchemists that can create value from seemingly intangible products, but in some ways they have become a product themselves – a financial asset that is traded by investors. Venture Capital seeks the outsized returns generated by building a billion dollar company (i.e. a company whose shares can be traded at a valuation of a billion dollars, not necessarily a company that produces profits and free cash worth a billion dollars over time – the latter are much more rare). According to research by Cowboy Ventures, the world sees approximately 3-4 unicorns created per year, and the occasional super-unicorn like Facebook, which is worth in excess of $100bn – implying that their returns are generated by approximately 0.07% of the companies in which they invest.

The generation of startups who grew up reading Techcrunch, watching startup pitch competitions and venerating VCs seems to largely buy into this idea that creating a business is like taking part in the X Factor or America’s Next Top Model, where the judges and financiers are the real stars, with the participants lucky to be along for the ride. In too many cases, even a successful outcome results in an ‘acqui-hire’ or an exit that leads directly to the “sunsetting” of the very product a business was built to create. In some cases a team can be paid off and the product closed down before it even launches, which is perhaps the literal opposite of the Japanese construction firm Kongō Gumi, the world’s oldest company, which was finally acquired after 1,400 years of operation when it fell on hard times in 2006.

Startups need VCs less than ever, are free to choose their own blend of goals and ambitions to pursue, and are facing a corporate landscape where structure and process have taken over from purpose and professionalism to such an extent that many large firms are ill-equipped to prosper in the Twenty-First Century.

So why is it that when they begin to grow, they so often feel a need to replicate the structural mistakes of the companies they seek to disrupt? Is it because they have internalised the narrative of finance and investment, and believe they must quickly appoint a CFO to guide them and a CEO to toughen them up whilst they squeeze themselves into an org chart designed for a C19th firm?

The minute you start drawing lines and boxes, you tell people how to align and communicate, which results in an “us versus them” mentality. And that’s the last thing you want at a start-up … It’s true employees are trained to ask for an org chart, though that’s not what they’re looking for. What they really want to know is how to make an impact at your company.

The cascading hierarchy is an historical artefact from the age before telephones, let alone real-time always-on communication. We simply don’t need it any more in its current form, which is not to say that some element of ‘Minimum Viable Hierarchy’ should not remain to help co-ordinate activities in a large, distributed firm. But it is also part of a business culture that values the appearance of work over substance, and means that if you wear the right things and use the right buzzwords, you can sometimes be promoted in a corporate structure regardless of talent and value created.

Ronald Coase’s 1937 article on the nature of the firm said that firms exist to reduce transaction costs, as they can organise internally to create goods or services more cheaply than if they had been acquired in the market; but in reality, many firms continue to grow and accrete power even when the reverse is true and it is more expensive to do the work internally than externally. These days, of course, the boundary between internal and external is blurring and it is no longer a simple binary choice, but the fact remains that managers have a tendency to over-bureaucratise because this gives them power, regardless of whether this makes sense for the firm and its shareholders.

This is especially true in businesses that have a principal source of outsized profit that subsidises the rest of the organisation, such as Oil companies, banks, and in the technology world, firms like Microsoft (Business and Server software) and Google (AdSense). As Vanity Fair pointed out in a long profile last year, Microsoft has suffered from over-bureaucratisation, but in particular from the toxic effects of its employee stack ranking system:

The story of Microsoft’s lost decade could serve as a business-school case study on the pitfalls of success. For what began as a lean competition machine led by young visionaries of unparalleled talent has mutated into something bloated and bureaucracy-laden, with an internal culture that unintentionally rewards managers who strangle innovative ideas that might threaten the established order of things.

Even Google seems to suffer a problem with management culture and organisational structure, according to the feedback of various former employees on this Quora thread about the experience of working there, which contains constant references to mediocre, but highly political middle management suppressing or wasting talent.

Organisation design and structure is an absolutely critical factor in creating a sustainable culture of performance and value creation for customers.

Social technology has been a welcome addition to the enterprise. It is now perfectly normal in business to have internal communication and sharing networks that enable any employee to connect with any other, and for them to instantiate a new project or collaboration space to discuss and solve problems in real-time. However, social technology is necessary, but it is not sufficient. What really matters are the new affordances of the technology – new behaviours and processes it makes possible – especially in enabling new ways of working. To really take advantage of these benefits, the organisation’s structure needs to flex and adapt. And that is not yet happening as rapidly or as confidently as we might hope.

There are many good examples of companies that have pioneered more task- or customer-centric structures that give employees the autonomy and freedom to create value, and most of these pre-date any use of social technology in the workplace. For example:

Haier: they went from a low-quality state enterprise to the biggest white goods supplier in the world, partly by placing customer-facing functions at the top of an inverted pyramid and by de-centralising based on strong shared values.

Kyocera: they have used an “amoeba management” system based on 3,000+ small teams (5-50 people) with a strong focus on performance.

Morning Star: a large tomato processing firm that works on the basis of mutual contracts between people and teams, with no formal line management at all.

Valve: an extremely autonomous organisation that manages without managers but focuses on tasks to be done – people choose where they can add the greatest value.

There is also a wealth of ideas around right now about innovations in organisational design and management thinking, with increasing attention being paid to ideas such as Holacracy, currently being used by Medium, and new management theory, as summarised here by Steve Denning.

In fact, even within the Meaning conference, we heard some great stories about how JustGiving is managed more through enquiry and hypothesis testing than grand top-down vision; how the Pirate Party turned its lack of resources into a formidable networked movement; and, how the philosophy and shared structure of the co-operative Mondragon Corporation has enabled it to survive and thrive whilst competitors have suffered from liquidity and other problems resulting from the financial crash.

In most cases, these companies all started with a sense of the model they wanted to use, rather than lazily adopting a standard corporate template. As Anne-Marie Huby from JustGiving explained during the event, it is much harder to retro-fit ‘purpose’ onto an organisation that does not have it – it should ideally be in the organisation’s DNA.

So why do so many startups struggle to develop their own organisational models? Rather than needing to ‘grow up’ and hire the sleazy sales guy their recruiter just put forward, could it be that startups are already have a more professional work culture (through necessity) than the corporates they seek to disrupt? There are many ways in which this is probably true, but here are five areas where I think the average startup already knows more than the average corporate:

Project planning and management: agile, scrum and lean methods are the norm, and tools such as Trello or Pivotal Tracker are common. You will be hard pushed to see a bunch of people sitting round an out of date GANTT chart all secretly knowing it is a fiction.

Devops: the secret heroes of the tech world, who keep the trains running on time. Look past the t-shirts and IT humour and you will find some of the most professional, organised, well-documented and automated environments in any company. They could teach traditional IT a thing or two.

The wiki way: if you see a problem, don’t escalate up the chain of command and start a turf war, just fix it yourself. Simple, direct, efficient.

Task-centric: the startup culture is very much about getting things done. As Medium put it: “eliminate all the extraneous factors that worry people so they can focus on work” – tasks are what matters, not status or hierarchy.

I have written before that I think startups should pay attention to the organisational design, structure and culture that can enable them to scale without losing their mojo. But perhaps we should set our sights higher and consider how we might create our own Twenty-First Century institutions, based on our own principles and ideas, which will still be around a hundred years from now.

I am fascinated by institutions, as they have an amazing ability to give longevity to ideas. The oldest European institution is probably the European model of the University, which first emerged in Bologna in 1088 and continues relatively unchanged to this day. Even some much more recent institutions, like the BBC, have taken an idea (in this case public service broadcasting) and protected it for close to a century amid seismic changes in broadcasting and business. If we can do something similar with the best business ideas of our generation, then I would not be surprised to find people still using them a hundred years from now, much like the way that the org chart still endures today, way beyond its sell-by-date.

The fast-and-loose business that is emerging as the new way of work runs more like a forest or a city than machinery. We need to learn by imitating rich ecosystems, where the appearance of chaos yields to emergent order, and reject order imposed by design.

But there is also one key lesson from the case studies and examples mentioned above. Small, task-focused, autonomous teams seem to be the basic unit of operation, not the divisional organisation. Small teams, like Dave Gray’s pods, mimic the natural size of a closely bonded group throughout human evolution (approx 8-15 – let’s say 12 – people), and when you scale up in a fractal way, by recombining teams into larger units (12^2), you reach Dunbar’s number, and then at the next level of scale (12^3) you reach a decent size for a village or business unit in a large firm, and then (12^4) a division, and finally (12^5) a very large company indeed. But the point about fractal structures is not how large they can scale, but how resilient they are along the way, since every level looks and operates the same, only on a different scale.

I also think we will see some other characteristics in the new ‘old firms’ that endure for a century or more, such as:

explicitly blended business goals – not only financial

better ecosystem thinking to reduce costs for all players

social technology + a new culture of work + new structural design

employ people, be situated in a community, contribute

sustainable ownership and funding models not just seeking IPOs

How we get there is a huge topic in itself, but obviously we are not talking about some kind of consultant-led ‘change programme’ using motivational posters and made-hp values. Also, whilst the discipline of management is less necessary than before, strong, visionary, supportive leadership is more vital than ever. For companies already in existence who want to experiment with new structures and work cultures, rather than start from scratch, I think the most important advice is to learn from the experience of the UK Government Digital Service and create protected spaces within which you can try things out until they become strong enough to survive the existing organisation’s inevitable immune response.